Question

In Adjusted present value approach, i know the calculations for any question but i have doubt in one thing

Dismiss the NPv calculations

If we have initial outlay for a project 100,000

And this is depreciated using 25% reducing balance.

You know that we have to construct a table, and find the depreciation for each year suppose for 4 years

Then we multiply depreciation * Tax. To get TS

Suppose we got. 40. 48. 49. 50. As a dep tS. Then we have to discount each of them and sum them, right ? My question is, we had a question in the lecture we discounted them on the risk free rate

Another question we discounted them at R0: cost of equity unleverged.

So my question is when do we discounted them on Rfr, when on R0 ? (Keep in mind that is the dep TC on th initial outlay or the project

Answer 1

The depreciation is computed using reducing balancing method. This amount is multiplied by the tax rate to arrive at the tax saving on depreciation. However this tax saving must be discounted to arrive at the Present value of the tax saving on depreciation.

The risk-adjusted discount rate is usually used to discount the cash flows. This rate is based on the risk-free rate and a risk premium which depends upon the expected level of risk associated with a stream of cash flows. The risk premium is increased if the investment risk is perceived to be high. Conversely, the risk premium may be zero if the investment risk is not present. In such a case the discount rate may be equal to the Risk free rate of interest.

In other cases where the risk premium is present in the investment, the cost of capital is used since the Cost of capital = Risk free rate + Risk premium.